Edited version of your private ruling

Authorisation Number: 1051849108324

Date of issue: 7 June 2021

Ruling

Subject: Disposal of commercial property - capital vs revenue

Question 1

Will the gain made from the proposed sale of the Property be a gain made from the mere realisation of a capital asset and a capital gain pursuant to subsection 104-10(4) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: Yes

Question 2

Will the anticipated profit be as a result of a transaction undertaken within the course of the business being carried on by the Taxpayer, and if so, will it be in the ordinary course of that business and therefore assessable as ordinary income pursuant to section 6-5 of the ITAA 1997 and consequently under section 118-20 of the ITAA 1997 apply to reduce the capital gain to zero?

Answer: No

Question 3

Will the anticipated profit be the result of a transaction, not in the ordinary course of the Taxpayer's business, but entered into with the intention or purpose of making a profit?

Answer: No

Question 4

Will section 118-25 of the ITAA 1997 apply to treat the CGT asset as trading stock?

Answer: No

This ruling applies for the following period:

Year ending 30 June 2021

The scheme commences on:

1 July 2020

Relevant facts and circumstances

1.    The Trust is part of the Group.

2.    Corporate Trust is the trustee of the Trust. The trustee's sole shareholder is Sporting Inc.

3.    The Group conducts the following types of activities:

•         Sporting activities;

•         Club management activities;

•         Property investment activities;

•         Passive investment activities; and

•         Property development activities.

4.    The Trustee for the Trust's (the Applicant) role in the Group is to invest surplus funds from the connected entities within the Group. Returns from those investments are then available to be utilised in the encouragement, fostering, promotion, development and assistance to their sport in their region.

5.    The Group has historically been financially supported through cashflow from ownership and operation of licensed clubs.

6.    In 2007, the Group diversified its investment strategy beyond the licenced club industry due to changes to government regulations and gaming laws. The strategy shifted the Group's preferred option to non-licenced club commercial properties. This strategy was articulated in a letter from the Group CEO.

I recommend that [the Group] start investing in residential and commercial property...our capacity allows us to achieve diversification by way of geography, we well as a mixture of residential and commercial property...These types of investments provide rental return and capital growth as well as being realisable".

7.    At this time, the focus of the Group was making passive investments in assets that would generate consistent, long-term cashflows to support the funding of the Group's sporting activities. The potential for realisable capital growth was not the focus of these investments and rather was considered an additional benefit on top of the consistent cashflows.

8.    In 2015, the Group diversified its investment strategy to include passive investment in listed shares, managed funds, fixed interest investments and REITs. This was done because of the lack of availability of suitable commercial investment properties.

9.    The Trust was settled in June 2011, and in July 2011 entered into a contract for the Property. This acquisition formed part of the diversification strategy entered into in 2007.

10.  On acquisition, the Property had a 10-year lease in place with five 5-year options.

11.  The purchase of the Property was in line with the diversified investment strategy implemented in 2007. This acquisition was made due to the quality of the tenant, strong rental return and fixed annual rental growth. It was hoped that the property would appreciate over time, however there were no expectations or plans for the realisation of the Property at the time that it was acquired.

12.  Since settlement, the Applicant's asset holdings have included:

•         Cash

•         Commercial real estate

•         An investment portfolio of shares & managed funds; and

•         Loans to related entities (based on their cash flow requirements).

13.  The Applicant's investment portfolio is managed externally, with meetings with the investment managers occurring approximately every 6 months with portfolio rebalances occurring if required. The portfolio invests into blue chip companies and managed funds.

14.  In 2017, an indicative valuation of the Property was obtained in order to understand its likely value if it were to be used for obtaining bank finance for other property development occurring within the Group. The valuation of the Property from this process was $X.

15.  Discussions were held with a financier regarding using the Property to secure a commercial bill facility to partly finance a property development occurring within the Group but separate to the Applicant.

16.  A formal application for finance was made in April 2020 and indicative terms were approved in June 2020.

17.  In mid-2020 the financier advised that due to the changes in the bank's security criteria following the onset of the COVID-19 pandemic, the Property would no longer be accepted as security for the development due to its short weighted average lease expiry & there being no guarantee that the Property's lease would be renewed at expiry.

18.  As a result of the financier's decision, the Group reassessed the Property's alignment with the Group's strategy and needs. The Group engaged a consultant in November 2020 to provide a market review of the property to determine the likelihood of the lease being renewed in July 2021.

19.  The advice received from that process in November 2020 indicated that the returns on the property were higher than other tenant sites and that the Property site was smaller than the tenant's most recent acquisition and ideal site. This indicated a high-risk that the tenant may not renew their lease or would renegotiate to terms less favourable to the Taxpayer. It was also noted that a key risk with the site was that it could take an extended time period to re-let given the limited number of alternate users.

20.  This confirmed that the Property was no longer aligned with the Group's investment strategy. At this time, the Group assessed the value of the Property at less than $X if the tenant did not renew their lease.

21.  The consultant indicated to the Group at this time that they believed they had a purchaser willing to pay greater than $X for the Property. In late November 2020, the consultant was engaged to facilitate an off-market sale of the Property.

22.  The sale contract was exchanged on 10 December 2020 with settlement occurring on 22 December 2020 for greater than $X.

23.  During the period that the Applicant owned the Property, no development activities were undertaken or contemplated with respect to the Property.

24.  The Applicant has never been involved with the Group's property development activities.

25.  The Applicant has not held any other commercial properties, however other commercial properties are held by entities within the Group.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5(1)

Income Tax Assessment Act 1997 Section 70-10

Income Tax Assessment Act 1997 Subsection 104-10(4)

Income Tax Assessment Act 1997 Subsection 108-5(1)

Income Tax Assessment Act 1997 Section 118-25

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 (Cth).

Question 1

Will the gain made from the proposed sale of the Property be a gain made from the mere realisation of a capital asset and a capital gain pursuant to subsection 104-10(4) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

The gain will be a capital gain pursuant to subsection 104-10(4).

Detailed reasoning

26.  Subsection 108-5(1) provides:

A CGT asset is:

(a) any kind of property; or

(b) a legal or equitable right that is not property.

27.  The Property is real property, which is a kind of property. It is therefore a CGT asset.

28.  The distinction between a 'mere realisation or change in investment' and 'an act done in what is truly the carrying on, or carrying out, of a business', is provided by Lord Justice Clerk in Californian Copper Syndicate v. Harris (Inspector of Taxes) (1904) 5 TC 159 at page 166:

What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being - Is the sum of gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?

29.  Lord Justice Clerk's approach was adopted with approval by the High Court of Australia in Whitfords Beach Pty Ltd v Commissioner of Taxation 82 ATC 4031, with Gibbs CJ stating at page 4034:

When the owner of an investment chooses to realize it, and obtains a greater price for it than he paid to acquire it, the enhanced price will not be income within ordinary usages and concepts, unless, to use the words of the Lord Justice Clerk..."what is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business".

30.  These principles were applied in Statham & Anor v. Federal Commissioner of Taxation (1988) 89 ATC 4070 (Statham), where it was held that the sale of a rural property that had been subject to four stages of subdivision was a mere realisation of the property. In their joint judgment, Woodward, Lockhart and Hartigan JJ provided at page 4076 that:

There is nothing surprising in the fact that they went about this realisation in a manner calculated to maximise their receipts. The fact that this occurred does not necessarily make the proceeds either profits from an undertaking or scheme, or income from a business.

31.  The Applicant has done less to maximise their receipts from the sale of the Property than was done in Statham. Throughout the period of ownership, no development activities were undertaken or contemplated with respect to the Property. The identification of the eventual purchaser arose from engaging an external party to undertake a market analysis of the Property.

32.  As such, the gain realised on the disposal of the property was a mere realisation enabled by a set of serendipitous circumstances and not the conclusion of an undertaking or scheme.

Question 2

Will the anticipated profit be as a result of a transaction undertaken within the course of the business being carried on by the Taxpayer, and if so, will it be in the ordinary course of that business and therefore assessable as ordinary income pursuant to section 6-5 of the ITAA 1997 and consequently under section 118-20 of the ITAA 1997 apply to reduce the capital gain to zero?

Summary

Theprofit from the sale of the Property is not a result of a transaction undertaken within the coure of a business carried on by the Applicant.

Detailed reasoning

33.  Subsection 6-5(1) provides:

Your assessable income includes income according to ordinary concepts, which is called ordinary income

34.  Per Commissioner of Taxation v. The Myer Emporium Limited (1987) 163 CLR 199 (Myer Emporium), a profit or gain made in the ordinary course of carrying on a business will be ordinary income.

35.  Per paragraph 32 of Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income, this will include:

a profit or gain arising from a transaction which is itself a part of the ordinary business of a taxpayer

36.  Throughout the period that the Applicant has owned the Property, no development activities were undertaken or contemplated with respect to the Property. It has been held for the purpose of returning regular ordinary income, in the form of rental receipts, in line with a passive investment strategy. The Applicant is therefore not carrying on a business of property development.

37.  The applicant's portfolio holdings are in line with a passive investment strategy focused on regular returns on investment rather than a focus on capital growth. These returns would then in turn be used by other entities within the Group to complete their own activities ultimately to facilitate the Group's sporting activities.

38.  The sale of the Property is outside of the usual course of these activities, and therefore the profits or gains made in relation to its sale is not a profit or gain arising from a transaction which is itself a part of an ordinary business of the Applicant.

39.  The profit or gain therefore will not be ordinary income of the Applicant on the basis of arising from a transaction that is part of its ordinary business.

Question 3

Will the anticipated profit be the result of a transaction, not in the ordinary course of the Taxpayer's business, but entered into with the intention or purpose of making a profit?

Summary

The profit from the sale of the Property will not be the result of a transaction entered into with the intention or purpose of making profit.

Detailed reasoning

40.  Paragraph 32 of TR 92/3 provides that profits or gains made in the ordinary course of carrying on a business will include:

a profit or gain arising from a transaction which is an ordinary incident of the business activity of the taxpayer, although not a transaction entered into directly in its main business activity

41.  It was held at page 210 of Myer Emporium that:

A profit or gain made as a result of an isolated venture or a "one-off" transaction will constitute income if the property generating a profit or gain was acquired in a business operation or commercial transaction for the purpose of profit-making by the means of giving rise to profit;

42.  This was discussed in Westfield Ltd v Commissioner of Taxation (1991) 28 FCR 333 at 342:

It does not, however, follow from the judgment in Myer, or, for that matter, from the judgments in any later cases, that every profit made by a taxpayer in the course of his business activity will be of an income nature. To so express the proposition is to express it too widely, and to eliminate the distinction between an income and a capital profit. A taxpayer carrying on a business might sell its headquarters in order to move to larger premises and make a profit over historical cost. The transaction of sale may be one which arises in the ordinary course of the taxpayer's business, but that profit will not ordinarily be income, particularly where,' at the time of acquisition of the site, there was no intention or purpose of profit-making by sale when the premises became too small.

43.  And further discussed in Rosgoe Pty Ltd v Commissioner of Taxation [2015] FCA 1231 at [25]:

When, later, the property was sold, "the profit here arose not from the purchase but from the sale and because the sale was not part of the profit-making scheme the profit did not arise 'from the carrying on or carrying out' of that scheme.

44.  The timing of the requisite intention or purpose is adopted by the Commissioner in TR 92/3 at paragraph 9:

If a transaction or operation involves the sale of property, it is usually, but not always, necessary that the Taxpayer has the purpose of profit-making at the time of acquiring the property.

45.  In determining the intention behind the acquisition of the Property, it is necessary to look at the controlling mind of the Trust's corporate trustee in accordance with paragraph 91 of TR 92/3:

In determining whether a company has the purpose of profit-making, the acts and intentions of the natural persons who control the company should be examined.

46.  In 2011, the investment strategy of the Group was aligned to focus on consistent returns over a long term. The acquisition of the Property was in line with this strategy.

47.  While the Group CEO asserted that that these forms of investments would provide realisable capital growth, that is not determinative of whether there was a profit-making intention in acquiring the Property.

48.  Throughout the period of ownership, no development activities were undertaken or contemplated with respect to the Property. The intention of the Applicant was to continue to hold the Property and determined to dispose of it after changing economic circumstances meant it no longer aligned with the Group's investment strategy.

49.  The intention behind the acquisition of the Property at the time of acquisition was to derive regular ordinary income, in the form of rental receipts, in line with a passive investment strategy and not to attain a profit from its sale.

50.  Therefore, the profit from the sale of the Property will not be ordinary income of the Applicant on the basis of arising from a transaction entered into with a profit-making intention.

Question 4

Will section 118-25 of the ITAA 1997 apply to treat the CGT asset as trading stock?

Summary

The Property will not be treated as trading stock.

Detailed reasoning

51.  Section 118-25 provides:

(1) A * capital gain or * capital loss you make from a * CGT asset is disregarded if, at the time of the * CGT event, the asset is:

(a) your * trading stock;

52.  Section 70-10 provides:

(1) Trading stock includes:

(a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a * business; and

(b) • live stock.

53.  The Property does not meet either of these definitions and therefore is not trading stock.